Question

discuss how overhead costs influence management decisions.

Answer 1

For every organization, there are two costs.

1. Direct Cost

2. Indirect cost

Indirect costs are those costs which are not related to a product or service directly. For Example, administration costs, accounting expenses, rent etc. These costs are substantial costs and hence should be allocated to finished goods correctly.

Following are the ways by which overhead costs influence management decisions:-

1. Fixing selling price:-

To determine the selling price of various products, it is imperative for an organisation to allocate Fixed and Variable overhead correctly, so that it is competitive and profit generating. Since, in case of overheads, we have to allocate the costs to various products, hence it is vital to analyse overheads.

2. Controlling costs:-

Overheads are of two types, fixed and variable. Fixed overheads are controlled by top management while, variable overheads are controlled by lower management. Hence, it is crucial to divide overheads, into two parts so that both lower and upper management can control the costs.

3. Evaluating capacity based decisions-

If management wants to evaluate, that weather it is beneficial to produce products in house or buy from outside , then it is very important to know about the capacity at which cost will increase especially fixed overheads.

For example, company got special order to supply 100 units of product X. It will give additional revenue of $1000. However, if it think of manufacturing it in house then it has to incur additional $2000 on supervisor salary. Therefore, it should buy from outside, because it will be economical. Supervisors salary comes under the category of fixed overhead. Hence, overhead costs is important for taking decisions.

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